SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
[x] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 For the fiscal year ended December 31, 1999
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from __________________ to __________________
Commission File No. 001-23407
SURREY, INC.
(Name of Small Business Issuer in its charter)
TEXAS 74-2138564
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
13110 TRAILS END ROAD
LEANDER, TEXAS 78641
(Address and zip code of principal executive offices)
512-267-7172
(Issuer's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Exchange Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, NO PAR VALUE ("COMMON STOCK")
REDEEMABLE COMMON STOCK PURCHASE WARRANTS ("WARRANT")
(Title of class)
Check whether the issuer: (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the preceding 12 months (or for such
shorter period that the registrant was required to file such reports) and (2)
has been subject to such filing requirements for the past 90 days.
Yes _X_ No ___.
Check if no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is contained in this form, and no disclosure will be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. |_|
The Issuer's revenues for the year ended December 31, 1999: $19,557,000
Aggregate market value of Common Stock held by non-affiliates as of March 27,
2000: $2,184,812.50
Number of Shares of Common Stock outstanding as of the close of business on
March 27, 2000: 2,472,727
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive Proxy Statement for Annual
Meeting of Shareholders to be held May 2, 2000 ("Proxy Statement") are
incorporated by reference into Part III hereof.
Transitional Small Business Disclosure Format: Yes ___ No _X_.
<PAGE>
PART I
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
Surrey, Inc. ("Surrey" or the "Company") specializes in the development
and manufacture of high quality transparent glycerin and specialty soap
products, as well as the production of certain personal care and home fragrance
products. The Company has built four successful retail brands and a strong
private label and contract manufacturing business for high-profile customers.
Surrey uses a proprietary process for manufacturing poured bar soaps that allows
the Company to produce unique and affordable original soap products in large
quantities with consistent quality. In addition, the Company manufactures a
small amount of traditional bar soap. Surrey also maintains a library of
chemical formulations for producing purer, milder and harder glycerin soap bars
primarily through the use of synthetic moisturizing ingredients rather than the
use of tallow (I.E., animal fat). The Company manufactures and sells home
fragrance products and a full line of potpourri products as part of its crafts
market product line. The Company also manufactures a line of high-end scented
candles that compliments its line of home fragrance products. See also
"Competition."
BACKGROUND
Surrey was incorporated in 1981 as a Texas corporation. The Company was
the successor to a venture begun in 1972 to market a brush, mug, and line of
shaving soap for men. Management began working to perfect techniques for
producing a milder bar soap for its shaving kits, and in 1979 began
manufacturing its own soap products and expanding a new library of soap
formulations. At that time, the Company discovered that specialty soaps were a
lucrative niche market which it believed was too small to attract significant
competition from the larger soap producers like Dial, Unilever,
Colgate-Palmolive and Procter & Gamble.
During the eighties, management began developing a new generation of
soap formulations and selling its products to drug store chains, supermarket
chains, and discount/mass merchandisers across the country. Surrey found that
the chemistry of most glycerin bar soaps made the soap soft and difficult to
process. Surrey's newly formulated glycerin soaps were firmer, lasted longer,
and could be used to create various unique shapes and formats, such as Surrey's
original "soap suspended in soap" products.
In the early nineties, Surrey entered the contract manufacturing
business and began producing specialty soap products for a variety of premier
brand consumer product companies and prestige accounts, including Elizabeth
Arden, Walt Disney Co., Avon, Ann Taylor, Wal-Mart, and Walgreen's. In 1990, the
Company acquired the assets of Simmer Scents, a line of potpourri home
fragrances and began selling to major craft chains.
In March 1987, the Company moved its operations to its current site in
Leander, Texas, close to Austin, originally occupying an 18,000 square foot
manufacturing plant. The Company has expanded several times over the years. Its
most recent expansion and remodeling, beginning in 1998, brought the total size
of its facilities to approximately 93,000 square feet, of which approximately
9,100 square feet contains the Company's corporate office and research facility,
approximately 25,900 square feet houses the production and manufacturing
facilities, and the remaining
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approximately 58,000 square feet are dedicated to warehousing and storage. See
also "Growth Strategy," "Bath & Body Works" and "Significant Customers."
PRODUCTS AND DISTRIBUTION
Surrey's principal product line has traditionally been its high quality
glycerin bar soaps which it markets, both directly and through manufacturers'
representatives, to a large variety of retail establishments, and which it
manufactures, on a contract basis, for a variety of private-label customers. In
addition, the Company now manufactures and markets a full line of potpourri
products and began producing a candle line in late 1998. The Company's total
sales mix in 1998 was approximately equally divided among (a) contract
manufacturing products, and (b) retail products, including soaps, shaving
products, potpourri, and craft products. For 1999, the total sales mix was
approximately 65% contract manufacturing and approximately 35% retail. This
change in 1999 was principally a result of the Company's large volume of
contract manufacturing business with Bath & Body Works in 1999.
The Company has a wide variety of private label and contract
manufacturing clients for which it makes specialty glycerin soap bars and other
products. Many of the retail customers, such as Bath & Body Works, Wal-Mart,
K-Mart, Walgreen's, Tupperware, and Sara Lee Direct, buy products designed,
created and manufactured exclusively by Surrey's personnel. Contract
manufacturing customers, such as Elizabeth Arden, Avon, Liz Claiborne and Walt
Disney Co., work closely with the Company to create a product unique to that
customer through the use of specialty designs, fragrances, labeling, colors and
shapes. Surrey, through its proprietary processes, has been successful in
creating unique shapes and designs, including its "soap in a soap," tailored
specifically for certain customer requests.
Surrey currently contracts with approximately 60 brokers and
manufacturers' representatives who sell the Company's products on a commission
basis to a variety of retail customers. All such brokers and manufacturers'
representatives sell products for manufacturers other than the Company. Such
products include both the Company's own branded products and private-label
products manufactured for such retailers under their individual labels. The
Company also produces, on a direct marketing basis, specialty products for a
variety of contract manufacturing customers. Those products are sold through
direct marketing efforts by the Company. The Company does not offer any products
through a retail catalogue.
Surrey currently markets its products under its own four premium
in-house brand names:
* THE TEA ROOM(TM) LINE * THE SIMMER SCENTS LINE
* candle line * potpourri bags
* potpourri * potpourri liquids
* soap * oils
* sachets
* THE SURREY MEN'S LINE * THE ILLUMATHERAPE(R) LINE
* shaving mug, brush and soap set * various shaped and
scented candles
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As part of its stated growth strategy, the Company intends to continue
to diversify its product mix. In mid-1997 the Company introduced a full line of
potpourri intended to capitalize on the Company's experience in producing high
quality fragrances. The Company's potpourri line is being sold both through
craft stores (such as Garden Ridge) and discount mass merchandisers (such as
Wal-Mart and K-Mart). At the end of 1998, the Company entered the candle market
with a line of high-end scented candles that compliments its line of home
fragrance products. The Company is currently developing a second candle line, to
produce clear wax candles. This second line, which will double the Company's
candle production capacity, is expected to be operational in April 2000. During
1999, the Company reintroduced its soap making kits as a holiday product. These
additional products have increased the Company's ability to market to craft
stores.
As part of its 1998 expansion, the Company also began manufacturing a
small amount of traditional bar soap. The Company does not expect to make
significant inroads into the traditional bar soap market; rather, the Company
intends to meet the existing demand of its customers for traditional bar soap.
The addition of a traditional line of bar soap allows the Company to offer a
more complete line of soap products including traditional soap products, liquid
soap, and glycerin bar soap. See also "Competition."
MANAGEMENT INFORMATION SYSTEM
During first quarter 2000, the Company begin a replacement and upgrade
of its entire management information system. In order to finance this project,
the Company entered into a $250,000 operating lease with Softech Financial. The
new system is currently expected to be completed and operational during third
quarter 2000. The upgrade consists of new hardware, new software and training
for Company employees. The new system is expected to improve efficiency and cut
costs for handling orders and sales, to improve inventory control and to help
track and manage general cost control.
GROWTH STRATEGY
Over the past several years, the Company has embarked on a growth
strategy designed to substantially increase revenue and profitability. To date,
the Company has met many of its stated goals and continues to work toward
developing others. The Company has expanded its business by:
* doubling its manufacturing and production capabilities during 1998
and 1999
* doubling its sales in 1999
* hiring additional professional sales personnel
* increasing its direct marketing and sales efforts to attract new
contract manufacturing customers
* continuing to diversify its product mix
* developing new products for its retail market
* continuing to shift its marketing emphasis to its higher margin
products
* hiring a human resources director to decrease labor costs
and turnover
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In 2000, the Company expects to focus on 1) continuing to develop new
products, such as its new clear wax candle line, increasing sales in all its
product lines, and entering into new markets, such as the UK and Europe; and 2)
cost containment to improve gross profit. The Company's gross profit margin was
approximately 15% in 1998 and increased to approximately 21% in 1999. The
Company's current goal is to improve gross profit margin to approximately 30%
over the next few years.
BATH & BODY WORKS
The Company announced in November 1998 that it received a major letter
of commitment from Bath & Body Works, a wholly owned subsidiary of The Limited,
Inc., to purchase Company products. The letter of commitment was carried out
through periodic purchase orders and no formal agreement was entered into
between Bath & Body Works and the Company.
In January 1999, Bath & Body Works placed an initial opening order for
approximately 2,000,000 bars of glycerin specialty soap products, for
approximately $1,000,000 in revenues. Total Bath & Body Work's purchases for
1999 were approximately 10,000,000 bars, for approximately $7,000,000 in
revenues.
As of March 2000, the Company had received year 2000 purchase orders
for approximately $1,000,000 from Bath & Body Works. Other than the initial
opening order to stock store shelves (which will not be repeated), the Company
expects, based on orders to date, that purchases by Bath & Body Works in 2000
will be approximately at the same level as 1999.
See also "Item 6, Management's Discussion and Analysis of Financial
Condition and Results of Operations - Liquidity and Capital Resources."
COMPETITION
While there is extensive competition in the bar soap manufacturing
industry, the Company believes that it currently competes directly with only a
small number of manufacturers in the specialty soap market, notably Neutrogena,
Beiersdorf (Basis), and Johnson & Johnson (Purpose). In addition, many other
companies manufacture and/or market a range of personal care products which
compete with Surrey's soap and other products. These companies include, among
others, Twincraft Soap Company, Original Bradford Soap Works and Stahl Soap. See
also "Proprietary Processes and Trademarks."
The Company also manufactures a small amount of traditional bar soap.
Within the traditional soap market, the Company competes directly with many
larger manufacturers, such as Procter & Gamble, Colgate-Palmolive, Unilever and
Dial, which are much larger and have greater financial resources than the
Company. The Company does not expect to make significant inroads into the
traditional bar soap market; rather the Company intends to meet the existing
demand of its customers for traditional soap.
The Company currently believes that it will experience little
competition from the large manufacturers of traditional bar soap in its
specialty soap niche market due to the small relative size of the market and the
larger relative cost to mass produce a high quality glycerin bar soap product.
These larger manufacturers may, however, present more competition to the Company
for its liquid soap products.
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In late 1998, the Company added a line of high-end scented candles to
compliment its potpourri and craft products. In April 2000, the Company expects
to have operational a second candle line to produce clear wax candles. This
second candle line is expected to double the Company's candle production
capacity. These additions are intended to add variety to the Company's product
line. The candle industry is highly competitive and dominated by larger
manufacturers, most of which have greater financial resources than the Company.
The Company currently believes that it experiences the majority of its
competition based on the variety of its product line, and to a lesser extent on
price. The Company is broadening its product line and believes its current and
intended diversification into traditional bar soaps, liquid soaps, potpourris,
high-end scented candles and crafts will be advantageous in its marketing, and
instrumental in helping it maintain a competitive position in its targeted
markets. However, as the Company continues its diversification into other
product lines and markets, it may experience competition from other sources, as
well as from foreign manufacturers.
SIGNIFICANT CUSTOMERS
Bath & Body Works accounted for approximately 36% of net sales in 1999
and Wal-Mart accounted for approximately 5% of net sales, down from 26% in 1998.
In 1998, no other customer accounted for more than 4% of net sales, and for
1999, no customer accounted for more than 3% of net sales. The decline in the
percentages for other customers was due principally to the exceptionally large
volume of orders from Bath & Body Works in 1999.
CUSTOMER CONTRACTS
The Company's large retail customers, such as Bath & Body Works,
Wal-Mart, K-Mart and Walgreen's generally establish their product order plans on
a 12 month cycle. Once such plan is in place it is often not reviewed for a
year; however, only the first order under any such plan is guaranteed. The
Company has no standing orders or long-term contracts with any of its retail
customers. Any such customer can re-order at any time or cancel or replace the
Company's product in its 12 month plan at any time with no notice to the
Company.
Most of the Company's contract manufacturing customers, such as
Elizabeth Arden, Avon and Walt Disney, order on a job-by-job basis only. Such
orders are generally cancelable by the customer if not shipped within two weeks
of the scheduled shipping date. Unless the Company is developing a new product
for a contract manufacturing customer (for which the development period can take
from months to years depending on the product and the customer), the Company
typically ships products within 60 to 90 days after receiving a purchase order.
Such period may be longer if special packaging or labeling is required by the
customer. Individual contract manufacturing clients generally supply the Company
with soap boxes and labeling; therefore, the Company is not required to carry
such inventory on its balance sheet. In addition, many of the Company's contract
manufacturing customers pay for the development and production of the die stock
and molds and, therefore, own such molds and the formulas for their individual
products.
Because the Company generally does not have any standing orders or
long-term contracts with its customers and orders are generally shipped within
60 to 90 days after receipt of purchase orders, the Company had no significant
backlog in 1999.
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PROPRIETARY PROCESSES AND TRADEMARKS
The Company holds no patents on any of its equipment or processes and
relies substantially on certain formulas and processes that are not patentable.
In addition, much of the Company's proprietary information is the experience and
knowledge of its employees, contractors and business partners. To protect these
rights, the Company requires certain contractors, business partners and
distributors to enter into confidentiality agreements. There can be no assurance
that these agreements will provide meaningful protection for the Company's trade
secrets, know-how or other proprietary information in the event of any
unauthorized use or disclosure; however, the Company intends to defend its
trademark and proprietary information as appropriate. Further, in the absence of
patent protection, the Company may be exposed to competitors who independently
develop substantially equivalent technology or otherwise gain access to the
Company's trade secrets, knowledge or proprietary information. The Company
became aware in mid-1997 that a company which signed such a confidentiality
agreement appears to be using certain trade secrets of the Company in violation
of their agreement. No action is currently contemplated in relation to such
violation. Management believes that such infringement is not material. Because
the Company is in a niche market, any significant volume from a competitor could
reduce the Company's sales and revenue.
The Company holds a registered trademark to use Hill Country Soap
Company(R), Pure Pleasure(R) and Illumatherape(R). The Company has applied for a
trademark to use Garden Party(TM) and Tea Room(TM). Although Surrey believes its
trademarks are important, it does not believe that its trademarks are material
to its business.
RESEARCH AND DEVELOPMENT
During fiscal years 1998 and 1999, the Company's principal research and
development activities have been experimentation in the Company's laboratory by
its own personnel and ideas brought to the Company by its customers. The Company
has historically spent significantly less than 5% of its net sales on research
and development. While research and development is important to the Company's
ongoing business and a significant portion of certain employees' time is
committed to this area, the costs of research and development in the Company's
product line is significantly less than for other types of manufacturing
companies.
SEASONALITY
The Company experiences seasonal fluctuations in operating results,
with sales and revenues generally higher during the third and fourth calendar
quarters. Orders shipped in the third and fourth quarters generally account for
approximately 60% of the Company's total net sales for the year, due primarily
to the holiday retail season. Generally, customers place holiday purchase orders
in the summer for initial shipment in August continuing through October. As a
consequence, the Company expects to hire full-time seasonal employees from May
through November to accommodate such increased production volume. During third
and fourth quarters the Company operates a third full-time production shift.
EMPLOYEES
As of March 1, 2000, Surrey employed 152 full-time employees and had no
part-time employees. The Company maintains two shifts of full-time production
personnel. In 2000, the Company is shifting away from its prior practice of
hiring temporary employees during its heaviest
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production periods, which were traditionally July through December, to a policy
of hiring full-time seasonal workers from May through November. In addition, the
Company has hired a professional human resources director to help decrease labor
costs and turnover and manage special orders.
The Company has 8 full-time employees in sales, marketing and design, 8
in administration and finance, 4 in research and development, 2 in procurement,
5 in production manufacturing, 6 in Quality Control and 4 in shipping and
handling.
The Company's employees are not represented by any collective
bargaining organization. The Company believes that its relations with its
employees are satisfactory.
SOURCES AND AVAILABILITY OF RAW MATERIALS
Substantially all of the raw materials (predominantly glycerin and
other chemicals) used by the Company to manufacture its products are of a
generic nature and are available from several suppliers. To the best knowledge
of the Company, none of the raw materials for its products is in short supply,
and all are readily available from a variety of distributors. In 1999, the
Company purchased four 10,000 gallon containers to store key raw materials.
Management believes by buying in bulk the Company slightly reduces the cost of
such raw materials. The Company does not anticipate any significant difficulties
in securing adequate supplies of raw materials of acceptable quality and prices
in the foreseeable future.
ITEM 2. DESCRIPTION OF PROPERTY
The Company owns the property and facilities that comprise its
production plant and corporate headquarters. The property consists of
approximately 12.50 acres in Travis County, Texas, approximately 22 miles
northwest of Austin. All of the Company's operations are currently centered in
one approximately 93,000 square foot single story warehouse building which
houses the offices, production facilities and warehouse and storage. Currently,
the Company's corporate offices and research facility occupy approximately 9,100
square feet, the production and manufacturing facilities occupy approximately
25,900 square feet, and the remaining approximately 58,000 square feet are
dedicated to warehousing and storage.
The Company entered into a construction contract with Van and Van
Austin of Austin, Texas to complete the 1999 addition of 14,000 square feet of
new warehouse space, the remodeling of 5,000 square feet of existing space into
a soap curing area and the remodeling of 4,000 square feet of existing space
into a candle room, at a total cost of approximately $480,000. The construction
was financed with approximately $380,000 under an additional term loan from
Chase Bank of Texas, N.A. and the balance from working capital.
The Company's production and manufacturing equipment generally is
leased under certain capital and operating equipment leases. To finance the
equipment necessary to complete its 1998 and 1999 expansions, and its new candle
line being completed in 2000, the Company has relied principally on the lease
lines of credit described under "Item 6, Management's Discussion and Analysis of
Financial Condition and Results of Operations - Liquidity and Capital
Resources."
The principal manufacturing equipment currently in use consists of
eight poured bar soap production line units, two liquid fill lines, one
traditional manufacturing soap line production unit
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and filler, four high speed wrapping machines, four low speed wrapping machines,
and one candle making line (a second candle making line is expected to be
operational in April 2000).
The Company's existing and future plant and equipment are pledged to
secure its outstanding bank loans. Management believes that the Company's
properties are adequately covered by insurance.
ITEM 3. LEGAL PROCEEDINGS
From time to time the Company is involved in legal proceedings arising
in the normal course of its business, none of which is expected to result in any
material loss to the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS.
There were no matters submitted to a vote of security holders during
the fourth quarter of the fiscal year covered by this report.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
MARKET INFORMATION
Surrey, Inc.'s Common Stock and Warrants are traded on the Nasdaq
SmallCap Market under the symbol "SOAP" and "SOAPW," respectively. The Company's
Units, which were comprised of two shares of Common Stock and one Warrant, began
trading on the Nasdaq SmallCap Market under the symbol "SOAPU" on December 4,
1997. On January 8, 1998, the Units were delisted, at the Company's request, and
the Units were separated into their component parts at such time.
As of March 17, 2000, there were 2,472,727 outstanding shares,
approximately 13 holders of record, approximately 736 beneficial holders of the
Common Stock, and 675,000 outstanding Warrants to purchase Common Stock. The
Warrants are exercisable on or before December 3, 2002 at an exercise price of
$4.80 per share. The Company may redeem the Warrants in whole at a price of $.01
per Warrant if the Company's price per share exceeds $5.00 per share for 20
consecutive trading days.
The following table sets forth the high and the low bid prices for the
Company's Common Stock, Warrants and Units for the four quarters of 1998 and
1999 as reported on the Nasdaq system. Prior to such time, the Company's Common
Stock, Warrants or Units were not publicly traded on a national exchange or
automated quotation system.
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Quarter Ended December 31, 1999 High Bid Low Bid
------------------------------- -------- -------
Common Stock $1.3125 $1.00
Warrant $.375 $.375
Quarter Ended September 30, 1999 High Bid Low Bid
-------------------------------- -------- -------
Common Stock $2.4375 $1.75
Warrant $.50 $.3125
Quarter Ended June 30, 1999 High Bid Low Bid
--------------------------- -------- -------
Common Stock $1.9375 $1.50
Warrant $.3438 $.3125
Quarter Ended March 31, 1999 High Bid Low Bid
---------------------------- -------- -------
Common Stock $2.5625 $1.9375
Warrant $.3438 $.3125
Quarter Ended December 31, 1998 High Bid Low Bid
------------------------------- -------- -------
Common Stock $2.875 $1.3125
Warrant $.6875 $.25
Quarter Ended September 30, 1998 High Bid Low Bid
-------------------------------- -------- -------
Common Stock $2.9375 $1.25
Warrant $.625 $.4375
Quarter Ended June 30, 1998 High Bid Low Bid
--------------------------- -------- -------
Common Stock $3.4375 $2.6875
Warrant $.6875 $.4375
Quarter Ended March 31, 1998 High Bid Low Bid
---------------------------- -------- -------
Common Stock $3.75 $3.25
Warrant $.75 $.625
The last sales price on March 27, 2000 was $1.625 per share for the
Common Stock and $.375 per Warrant.
DIVIDEND POLICY
The Company has not issued any dividends to stockholders. The Company
currently intends to retain earnings for use in the operation and expansion of
its business and therefore does not anticipate paying any cash dividends in the
foreseeable future. The Company's bank loan restricts the payment of any
dividends or purchase by the Company of any shares of Common Stock without the
prior written consent of the lender. See "Item 6. Management's Discussion and
Analysis of Financial Condition and Results of Operations."
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ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction
with the Financial Statements and Notes thereto appearing elsewhere in this
Annual Report.
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated certain items
in the Company's Statements of Operations expressed as a percentage of net sales
for that period:
Year Ended
December 31,
--------------------
1999 1998
---- ----
Net Sales .............................. 100% 100%
Costs of Goods Sold .................... 79.3 85.0
Gross Profit ........................... 20.7 15.0
Operating Expenses
Research and Development ........... 1.7 1.8
Sales and Marketing ................ 5.2 8.9
General & Administrative ........... 10.1 16.8
Interest Expense ....................... 2.3 2.5
Net Earnings (Loss) .................... .8 (9.2)
YEARS ENDED DECEMBER 31, 1999 AND 1998
NET SALES. Net sales for the Company reflect total sales less cash
discounts and estimated returns. Net sales increased to $19,557,000 in 1999 from
$9,247,000 in 1998, an increase of 111.5%. The substantial increase in net sales
for 1999 is primarily attributable to shipments for three major accounts. During
the first six months of 1999, the Company delivered opening order shipments
(initial shipments of products to stock store shelves) for two major accounts,
Bath & Body Works glycerin soap and Minnetonka Brands, for its "Star Wars"
retail soap distribution project. During third quarter, the Company shipped
large follow-on orders to Bath & Body Works and a large potpourri products order
to Wal-Mart to be included in their regular Christmas promotion program. Sales
to existing customers continued to be strong throughout fourth quarter. In
addition, during 1999 the Company's scented candle products were shipped in
substantial quantities for the first time. Since the successful completion of
the Company's expansion, and with the new manufacturing equipment on-line and
operational, the Company's sales staff has continued the marketing of new
product lines in order to take full advantage of the new manufacturing
facilities.
GROSS PROFIT. Gross profit increased in 1999 to $4,056,000 from
$1,391,000 in 1998. As full production capacity came on-line in March 1999, the
Company shifted its focus from plant and equipment upgrades to improving its
gross profit margin. The Company has shown strong improvement in gross profit
margin for 1999, with gross profit margin increasing from approximately 15% in
1998 to approximately 21% in 1999. Strong sales growth, without a corresponding
increase in costs, was the primary factor in 1999's improved gross profit
margin. For 2000, the Company expects to focus on reducing labor costs and
increasing sales. These efforts, coupled with the Company's 1999 expansion of
its production facilities and installation of more labor efficient equipment, is
expected to allow the Company to further reap the benefits of improved economies
of scale, resulting in continued improvement of its gross profit margin.
OPERATING EXPENSES. Operating expenses increased in 1999 by 31.7%
compared to 1998, but decreased sharply as a percentage of net sales; $3,344,000
(or 17.1% of net sales) in 1999, as compared to $2,539,000 (or 27.5% of net
sales) in 1998.
Operating expenses increased due to increased sales efforts, but
decreased as a percentage of sales primarily because of the significant increase
in net sales, which resulted in a positive effect on the ratio of net sales to
fixed operating expenses. The Company expects to focus during 2000 on decreasing
labor costs and increasing sales; therefore, this favorable trend in the ratio
between net sales and fixed operating expenses is expected to continue
throughout 2000.
Sales and marketing expenses increased in 1999 compared to 1998, but
decreased as a percentage of net sales. Such expenses increased from $821,000
(or 8.9% of net sales) in 1998 to $1,020,000 (or 5.3% of net sales) in 1999. The
overall increase for 1999 was primarily due to increased advertising and
increased sales commissions, which are generally based on a percentage of sales.
General and administrative expenses increased in 1999 as compared to
1998, but also decreased as a percentage of net sales, from $1,552,000 (or 16.8%
of net sales) in 1998 to $1,982,000 (or 10.2% of net sales) in 1999. The actual
increases in general and administrative expenses were primarily due to increased
salaries for sales and marketing personnel. The decrease in such costs as a
percentage of net sales was due to the large increases in net sales in 1999.
INTEREST EXPENSE. Interest expense increased substantially in 1999, but
remained relatively constant as a percentage of net sales. Interest expense was
$448,000 (2.3% of net sales) for 1999, as compared to $230,000 in 1998 (2.5% of
net sales). Increased interest costs resulted from the increase in long-term
debt to fund the new facility expansion, lease financing of $2,800,000 for new
manufacturing equipment, and short-term borrowings for working capital purposes
related to the Company's rapid sales growth in 1999.
PROVISION (BENEFIT) FOR INCOME TAXES. Income tax expense reflects a
combined federal and state effective rate of 39.8%. Based on expectations of
taxable income, the effective rate for the Company may vary from 37% to 40%
depending on levels of pre-tax income.
-11-
<PAGE>
YEARS ENDED DECEMBER 31, 1998 AND 1997
NET SALES. Net sales for the Company reflect total sales less cash
discounts and estimated returns. Net sales increased to $9,247,000 in 1998 from
$9,185,000 in 1997, an increase of 0.7%. This small increase in net sales is
attributed primarily to the fact that the Company's 1998 expansion was not fully
completed until the end of the fourth quarter of 1998, approximately six months
later than expected. This delay meant that the Company could not begin to use
its expanded production capabilities until first quarter of 1999. As a result,
the Company's sales efforts in 1998 were restricted by production capacity and
its inability to manufacture new product lines contemplated by the expansion.
GROSS PROFIT. Gross profit decreased in 1998 to $1,391,000 from
$2,392,000 in 1997, a decrease of 41.8%. Gross profit margin also decreased from
25.7% in 1997 to approximately 15.0% in 1998. This decrease in gross profit and
gross profit margin is attributed to flat net sales growth coupled with an
increase in cost of sales. The increase in cost of sales is attributed primarily
(i) to a disposal of inventory for no proceeds in the fourth quarter and
inventory shrinkage, valued in the aggregate at approximately $200,000, and (ii)
increased direct factory costs, primarily labor costs related to production
inefficiencies. Production inefficiencies resulted from a lack of sufficient
manufacturing and storage space pending the Company's expansion, which increased
in the fourth quarter due to higher holiday season production levels. Labor
costs also increased in the fourth quarter because the Company began to hire
additional workers in anticipation of production of the Bath & Body Works
purchase order.
The Company does not expect any significant disposal of inventory in
1999. The Company also expects that labor costs as a percentage of sales (23.8%
in 1998) will decline in 1999. As a result of the new expansion, an improvement
in labor efficiency is expected in 1999 due to new equipment and the possibility
for more efficient production scheduling. The Company also expects that product
margins will improve in 1999 with increased sales of new higher margin product
lines, particularly the scented candle product line.
OPERATING EXPENSES. Operating expenses increased in 1998 by 45.5% and
increased as percentage of net sales; $2,539,000 or 27.5% of net sales in 1998,
as compared to $1,745,000 or 19.0% of net sales in 1997. Operating expenses
increased as a percentage of net sales primarily due to increased sales and
marketing expenses and to increased general and administrative expenses.
A major component of the increase in sales and marketing expenses was
salaries related to the five sales positions added in 1998. Sales and marketing
related salaries increased to $360,000, or 3.9% of net sales in 1998, over
$68,000 or .7% of net sales in 1997. Also, travel expenses due to the increased
sales and marketing efforts increased to $119,000 or 1.2% of net sales in 1998
over $55,000 or .6% of net sales in 1997. The Company expects that these
additional investment costs will begin to be recovered in 1999 as revenue
increases due to the sales efforts begun in 1998.
General and administrative expenses increased to $1,552,000 in 1998
from $1,101,000 in 1997, and increased as a percentage of net sales to 16.8% in
1998 from 12.0% in 1997. This increase was due to higher legal and professional
expenses incurred by the Company in order to fulfill its expanded duties and
obligations as a public company and higher insurance costs due to larger
payrolls and expanded property and equipment coverage.
-12-
<PAGE>
INTEREST EXPENSE. Interest expense decreased to $230,000 in 1998 from
$278,000 in 1997, and decreased as a percentage of net sales to 2.5% of net
sales in 1998 from 3.0% in 1997. This decrease in interest expense is due to the
payoff of the Company's short-term working capital loan due to Norwest Bank
Texas, South Central prior to establishing a new banking relationship.
PROVISION (BENEFIT) FOR INCOME TAXES. As a result of the Company's loss
before income taxes in 1998, the Company recognized a benefit for income taxes
of $485,000 in 1998 compared to a provision for income taxes of $147,000 in 1997
and recorded a net deferred tax asset of $360,000 in 1998 compared to a net
deferred tax liability of $11,000 in 1997. The Company expects to utilize
approximately $138,000 of the 1998 deferred tax asset as a carry-back against
income taxes previously paid, and believes it is more likely than not that the
Company will generate sufficient taxable income in the future to realize the
remainder of the deferred tax asset, primarily because of the additional $6
million of revenues expected in 1998 from the Bath & Body Works letter of
commitment.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of liquidity are cash flow from
operations, bank borrowings, and lease financing.
Under a Loan Agreement with Chase Bank of Texas, National Association
("Lender") the Company currently has two outstanding term loans and a revolving
line of credit to be used for working capital purposes. The Company has (a) a
construction/term loan in the original principal amount of $2,300,000 ("Term
Loan") with a final maturity in April 2005, of which $2,175,000 was outstanding
at December 31, 1999, and (b) an additional term loan, in the original principal
amount of $400,000 ("Additional Term Loan") with a maturity of February 2004, of
which $365,000 was outstanding at December 31, 1999. The proceeds of these terms
loans were used to repay outstanding debt and to finance the Company's 1998 and
1999 expansion of the plant and facilities.
The Company's current revolving line ("Revolving Note") with the Lender
is based on eligible accounts and has a final maturity in April 2000. Amounts
currently available under the Revolving Note include the lesser of (A) 80% of
Eligible Accounts (as defined) plus the lesser of (i) 100% of the Eligible
Purchase Orders (as defined) from Bath & Body Works and Minnetonka Brands and
(ii) $500,000 or (B) $2,500,000. Such percentages are subject to decrease by the
Lender in certain circumstances. As of March 1, 2000, the Company had
$2,500,000 outstanding under the Revolving Note and no excess borrowing
capacity.
On March 29, 2000, the Company reached agreement with the Lender on new
financing arrangements. These arrangements require the Company to move $1
million of the amounts currently outstanding under the Revolving Note into an
additional term loan ("New Term Loan") which is due in 36 monthly installments
of $27,778 plus interest. Additionally, the Company's line of credit will
increase to $3 million. Under the terms of the new agreement, the Company will
have $1.5 million of additional credit available subject to borrowing base
requirements under the new agreement.
As part of its current negotiations with the Lender, (a) interest on
each of the Additional Term Loan, the New Term Loan and the Revolving Note will
float at the Lender's Prime Rate plus 1%, and (b) interest on the Term Loan will
be fixed at 8.50%.
-13-
<PAGE>
The Company and the Lender have amended the financial covenants under
the Loan Agreement on several occasions to provide for reduced financial
covenants. Currently, the Loan Agreement, as amended, contains (among other
requirements) the following covenants which are tested quarterly. The Company
must maintain (a) a current ratio of not less than 1.25 to 1.00 as of the end of
each calendar quarter after June 30, 1999; (b) a debt to tangible net worth
ratio not greater than 2.25 to 1.00 as of the end of each calendar quarter after
June 30, 1999; and (c) a debt service coverage ratio of (i) not less than 1.20
to 1.00 as of June 30, 1999, with the numerator of the debt service coverage
ratio being calculated by multiplying EBITDA for the second calendar quarter of
the 1999 calendar year by four (4) as opposed to calculating it on a rolling
four quarters basis; (ii) not less than 1.20 to 1.00 as of September 30, 1999,
with the numerator of the debt service coverage ratio being calculated by
multiplying EBITDA for the second and third calendar quarters of the 1999
calendar year by two (2) as opposed to calculating it on a rolling four quarters
basis; (iii) not less than 1.20 to 1.00 as of December 31, 1999, with the
numerator of the debt service coverage ratio being calculated by multiplying
EBITDA for the second, third and fourth calendar quarters of the 1999 calendar
year by four-thirds (4/3) as opposed to calculating it on a rolling four
quarters basis; and (iv) not less than 1.20 to 1.00 thereafter, with the
numerator of the debt service coverage ratio being calculated on a rolling four
quarters basis, tested for compliance on March 31, 2000 and as of the end of
each calendar quarter after March 31, 2000.
At December 31, 1999, the Company was in compliance with each of the
above required tests.
The Company and Lender also entered into an interest rate risk
management program for the term loans, pursuant to which the Company and Lender
entered into an ISDA Agreement (International Swap Dealers Association) intended
to hedge the interest rate fluctuations on the Term Loan. Overdue amounts on all
loans are payable at a past due rate of interest. The loans are secured by a
lien on the Company's plant, equipment, inventory, and accounts receivable.
Interest on each of the term loans and the Revolving Note is payable
monthly. Under the agreement being negotiated with the Lender, the Company will
be required to pay down the Revolving Note and maintain a zero balance for 30
consecutive days once prior to its maturity in April 2001. Principal on the term
loans is payable in monthly installments, which, under the terms being
negotiated, are expected to aggregate approximately $43,700 per month,
increasing to approximately $46,200 per month after April 2001.
The Loan Agreement, as amended, also limits indebtedness by the
Company, restricts borrowing under certain equipment leases to $2,000,000,
restricts the Company from making or incurring capital expenditures exceeding
$2,000,000 in any 12 month period, restricts indebtedness in connection with
acquisition of equipment to $200,000 and limits sales of assets. The Loan
Agreement also restricts the Company from making any dividends or distributions
on its capital stock unless net income equals or exceeds $2,000,000,
repurchasing or redeeming any capital stock (other than pursuant to the terms of
the Company's Warrants, provided no default would occur under the bank loans),
paying any bonus or other non-salary compensation, replacing its President or
Chief Financial Officer, or entering into certain related party transactions
without prior written consent of Lender.
-14-
<PAGE>
The Company leases certain pieces of its manufacturing equipment
pursuant to capital leases. The capital leases currently in effect have maturity
dates ranging from dates during 2000 to 2003. Such leases provide that if no
event of default exists thereunder the Company may purchase the equipment
subject to the lease at the expiration of the lease or may renew the lease.
The Company has a lease line of credit with Key Corporate Capital, Inc.
(due in 2005) which allows for a $1,562,000 leasing line of credit. The
equipment currently leased under this agreement includes two poured soap lines
dedicated to manufacturing glycerin soap, four high speed wrapping machines and
one candle making line. The Company drew the entire amount under this line of
credit in 1998. The Chief Executive Officer of the Company has personally
guaranteed this lease line of credit. Payments under this line are approximately
$288,400 per year or $24,000 per month.
The Company also has two three year capital lease lines of credit,
originally with Winthrop Resources, Inc. one (entered into in January 1999) in
the amount of $477,000 (used to finance one traditional soap making line) and
one (entered into in March 1999) in the amount of approximately $300,000 (used
to finance the purchase of bulk storage containers and related construction).
The Company has fully utilized these lines of credit. Payments under these two
lines of credit total approximately $300,000 per year or $25,000 per month.
The Company also has a three year capital lease line of credit,
originally entered into in March 1999 with Amembal Capital Corporation, in the
total amount of approximately $416,000 (used to finance three poured soap lines
dedicated to manufacturing glycerin soap and required to complete the 1999
expansion). Payments under this line of credit are approximately $70,900 per
year or $5,900 per month.
During first quarter 2000, the Company entered into new three-year
$250,000 operating lease with Softech Financial to provide for the complete
replacement and upgrade of the Company's computer system. As of March 27, 2000
approximately $180,000 had been drawn under this line. Once the line is fully
drawn, which is expected to occur upon the completion of the system upgrade in
third quarter 2000, payments under this line of credit will be approximately
$96,000 per year or $8,000 per month.
Currently, the Company is negotiating an additional three-year $200,000
operating lease line of credit with Celtic Leasing to provide financing for the
Company's new candle line. The development of this new line has been financed to
date out of operating funds, which are expected to be replaced by the proceeds
of this line of credit during second quarter 2000, when the candle line is
expected to become operational. Payments under this line of credit are expected
to be approximately $90,000 per year or $7,500 per month.
The Company believes that cash expected to be provided by future
operations and its current bank loans and financing leases will be sufficient to
meet its working capital and anticipated capital expenditure requirements during
2000. However, the Company may need to seek additional working capital financing
if net sales increase more than currently anticipated.
The Company experiences seasonal fluctuations in operating results,
with sales and revenues generally higher during the third and fourth calendar
quarters, reflecting primarily
-15-
<PAGE>
orders for the holiday retail season. Orders shipped in the third and fourth
quarters generally account for approximately 60% of the Company's total net
sales for the year.
FORWARD LOOKING INFORMATION
Statements contained in this report regarding the Company's future
operations, growth strategy, future performance and results, its ability to meet
its working capital and capital expenditure needs and its anticipated liquidity,
and the reduction of labor costs as a percentage of net sales are
forward-looking and therefore are subject to certain risks and uncertainties.
Any forward-looking information regarding the operations of the Company
will be affected by the continued receipt of large orders from the Company's
significant customers including Bath & Body Works, the Company's ability to
effectively manage its costs of operation, its ability to continue to increase
its marketing and sales efforts in order to take advantage of its increased
production facilities, the ability of the Company and its Lender to agree on
amended financial terms, and the continued availability of all of the Company's
lines of credit.
Any forward looking information regarding an increase in the Company's
gross profit margin also will be affected by the Company's ability to implement
its strategy of focusing on the sales of higher margin products as well as the
Company's ability to efficiently utilize its expanded facilities and effectively
manage its labor costs. There can be no assurance that the Company will be
successful in efficiently managing its growth in order to maximize potential
production.
ITEM 7. FINANCIAL STATEMENTS.
The following financial statements are included on the pages indicated:
INDEX TO FINANCIAL STATEMENTS PAGE
- ----------------------------- ----
Report of Independent Certified Public Accountants.......................... F-1
Report of Prior Independent Auditors........................................ F-2
Balance Sheets as of December 31, 1998 and 1999............................. F-3
Statements of Operations for the years
ended December 31, 1998 and 1999............................................ F-4
Statements of Shareholders' Equity for the
years ended December 31, 1998 and 1999...................................... F-5
Statements of Cash Flows for the years
ended December 31, 1998 and 1999............................................ F-6
Notes to Financial Statements............................................... F-7
-16-
<PAGE>
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
On August 2, 1999 the Company and Ernst & Young LLP ("E&Y") mutually
ceased their client-auditor relationship. E&Y served as the Company's
independent certifying auditors for the fiscal years 1995, 1996, 1997 and 1998.
No report of E&Y during its tenure as auditor contained an adverse opinion or
disclaimer of opinion or was qualified or modified in any way.
On November 9, 1999 the Company agreed to retain Grant Thornton LLP
("Grant Thornton") as its certifying accountants to audit the Company's
financial statements for the fiscal year ended December 31, 1999. Prior to this
engagement, the Company had not consulted with Grant Thornton with respect to
any other transaction or financial information.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
WITH SECTION 16(a) OF THE EXCHANGE ACT.
Information regarding directors and executive officers of the company
is set forth under "Information concerning Directors, Nominees and Executive
Officers" and under "Section 16(a) Beneficial Ownership Reporting Requirements"
in the Company's definitive Proxy Statement for its 1999 Annual Meeting of
Shareholders to be held May 2, 2000, and is incorporated herein by reference.
ITEM 10. EXECUTIVE COMPENSATION.
Information regarding executive compensation is set forth under
"Executive Compensation" in the Company's definitive Proxy Statement for its
1999 Annual Meeting of Shareholders, to be held May 2, 2000, and is incorporated
herein by reference.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
Information regarding security ownership of certain beneficial owners
and management is set forth under "Beneficial Ownership of Common Stock" in the
Company's definitive Proxy Statement for its 1998 Annual Meeting of
Shareholders, to be held May 2, 2000, and is incorporated herein by reference.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Information regarding certain relationships and related transactions is
set forth under "Information Concerning Directors, Nominees and Executive
Officers" in the Company's definitive
-17-
<PAGE>
Proxy Statement for 1999 Annual Meeting of Shareholders to be held May 2, 2000,
and is incorporated herein by reference.
ITEM 13. EXHIBITS LIST AND REPORTS ON FORM 8-K.
(a) EXHIBITS LIST
Number Description
- ------ -----------
* 3.1 Articles of Incorporation, as amended to date
* 3.2 Amended and Restated By-laws
+ 4.2 Form of Warrant Agreement and Warrant Certificate
o* 10.1 1997 Long-Term Incentive Plan
o* 10.2(a) 1997 Non-Employee Directors' Stock Option Plan ("Directors' Plan")
o 10.2(b) Amendment to Directors' Plan
o* 10.3 Employment Agreement, effective December 1997, between Surrey, Inc.
and John van der Hagen
o* 10.4 Employment Agreement, effective December 1997, between Surrey, Inc.
and Martin van der Hagen
o* 10.5 Form of Consulting Agreement between the Company and Stuart,
Coleman & Co., Inc.
** 10.6 Loan Agreement, April 8, 1998, between Company and Chase Bank of
Texas, National Association ("Lender")
** 10.7 Construction Loan Agreement, April 8, 1998, between Company and
Lender
** 10.8 Security Agreement between Company and Lender securing all
obligations of the Company to Lender under the Loan Agreement.
** 10.9 Promissory Note, in the face amount of $2,300,000.00, due to Lender
April 8, 2005
** 10.10 Master Equipment Lease between the Company and Key Corporate
Capital, Inc.
***10.11 Second Amended Loan Agreement, January 25, 1999, between Company
and Lender
***10.12 Construction Loan Agreement, January 25, 1999, between Company and
Lender
***10.13 Promissory Note, in the face amount of $400,000.00, due to Lender
February 8, 2004
***10.14 Promissory Note, in the face amount of $2,000,000.00, due to Lender
April 8, 2000
10.15 Third Amendment of Loan Agreement, March 31, 1999, between the
Company and Lender (incorporated by reference to the Company's
quarterly report dated May 14, 1999).
10.16 Fourth Amendment of Loan Agreement, June 17, 1999, between the
Company and Lender (incorporated by reference to the Company's
quarterly report on Form 10-QSB dated August 13, 1999).
10.17 Fifth Amendment of Loan Agreement, effective June 30, 1999, between
Company and Lender (incorporated by reference to the Company's
quarterly report on Form 10-QSB dated November 12,1999).
10.18 2000 Long-Term Incentive Plan [filed herewith]
16 Letter from former certifying accountant (incorporated by reference
to the Company's report on Form 8-K dated August 4, 1999).
27 Financial Data Schedule [filed herewith]
- ------------------
* incorporated by reference to the Company's registration statement on
Form SB-2 dated September 16, 1997 (Reg. No. 333-35757)
-18-
<PAGE>
+ incorporated by reference to the Company's Amendment No. 1 to the
registration statement on Form SB-2 dated November 12, 1997 (Reg. No.
333-35757)
** incorporated by reference to the Company's quarterly report on Form
10-QSB dated May 15, 1998
++ incorporated by reference to the Company's quarterly report on Form
10-QSB dated November 16, 1998
*** incorporated by reference to the Company's annual report on Form
10-KSB for December 31, 1998
o Items that are management contracts or compensation plans or
arrangement required to be filed as an exhibit to the Form 10-KSB
(b) REPORTS ON FORM 8-K
[N/A]
-19-
<PAGE>
SIGNATURES
In accordance with the requirements of Sections 13 or 15(d) of the
Securities Exchange Act, the registrant caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
SURREY, INC.
Date: March 29, 2000 By /s/ John B. van der Hagen
--------------------------------------
John B. van der Hagen
Chief Executive Officer
Pursuant to the requirements of the Exchange Act, this 10-KSB has been signed
below by the following persons on behalf of the Issuer on March 29, 2000 in the
capacities indicated.
/s/ John B. van der Hagen Chairman of the Board of
- ---------------------------------- Directors and
John B. van der Hagen Chief Executive Officer
/s/ Martin van der Hagen President and Director
- ----------------------------------
Martin van der Hagen
/s/ Mary van der Hagen Secretary and Director
- ----------------------------------
Mary van der Hagen
/s/ Bruce A. Masucci Director
- ----------------------------------
Bruce A. Masucci
/s/ G. Thomas MacIntosh Director
- ----------------------------------
G. Thomas MacIntosh
/s/ Mark J. van der Hagen Vice President - Finance and
- ---------------------------------- Treasurer
Mark J. van der Hagen
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors and Shareholders
Surrey, Inc.
We have audited the accompanying balance sheet of Surrey, Inc. as of December
31, 1999, and the related statements of operations, shareholders' equity and
cash flows for the year then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Surrey, Inc. at December 31,
1999, and the results of its operations and its cash flows for the year then
ended, in conformity with accounting principles generally accepted in the United
States.
GRANT THORNTON LLP
Dallas, Texas
March 22, 2000, except for the last
paragraph of Note D, as to which
the date is March 29, 2000
F-1
<PAGE>
Report of Independent Auditors
Board of Directors and Shareholders
Surrey, Inc.
We have audited the accompanying balance sheet of Surrey, Inc. as of December
31, 1998, and the related statements of operations, shareholders' equity and
cash flows for the year ended December 31, 1998. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Surrey, Inc. at December 31,
1998, and the results of its operations and its cash flows for the year ended
December 31, 1998, in conformity with generally accepted accounting principles.
/s/ Ernst & Young LLP
Austin, Texas
February 9, 1999 except for
Notes 7 and 14, as to which
the date is March 15, 1999
F-2
<PAGE>
SURREY, INC.
BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
December 31,
---------------------
ASSETS 1999 1998
-------- --------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ -- $ 77
Accounts receivable, net of allowance for doubtful accounts
of $116 and $106 in 1999 and 1998, respectively 4,091 1,713
Inventories 2,838 2,232
Prepaid expenses and other current assets 23 315
Deferred income taxes 143 182
Income taxes receivable 40 156
-------- --------
Total current assets 7,135 4,675
Property and equipment, net 4,237 3,710
Deferred income taxes 113 178
-------- --------
$ 11,485 $ 8,563
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Bank overdrafts $ 450 $ --
Trade accounts payable 1,724 1,159
Accrued expenses 312 204
Current maturities of long-term debt 418 134
Current maturities of capital lease obligations 204 208
-------- --------
Total current liabilities 3,108 1,705
Long-term debt, less current maturities 4,732 3,192
Capital lease obligations, less current maturities 196 376
Commitments and contingencies -- --
Shareholders' equity
Common stock; no par value; 10,000 shares authorized;
2,473 shares issued and outstanding 4,099 4,099
Common stock warrants; 737 authorized; 675 issued
and outstanding 64 64
Accumulated deficit (714) (873)
-------- --------
Total shareholders' equity 3,449 3,290
-------- --------
$ 11,485 $ 8,563
======== ========
</TABLE>
The accompanying notes are an integral part of these statements.
F-3
<PAGE>
SURREY, INC.
STATEMENTS OF OPERATIONS
(in thousands, except per share data)
Years ended
December 31,
---------------------
1999 1998
-------- --------
Net sales $ 19,557 $ 9,247
Cost of sales 15,511 7,856
-------- --------
Gross profit 4,056 1,391
Operating expenses
Research and development 342 166
Sales and marketing 1,020 821
General and administrative 1,982 1,552
-------- --------
Total operating expenses 3,344 2,539
-------- --------
Income (loss) from operations 712 (1,148)
Other income (expense)
Interest expense (448) (230)
Other income -- 44
-------- --------
Income (loss) before income taxes 264 (1,334)
Provision (benefit) for income taxes 105 (485)
-------- --------
Net earnings (loss) $ 159 $ (849)
======== ========
Earnings (loss) per share - basic and diluted $ 0.06 $ (0.34)
======== ========
Weighted average shares outstanding
Basic and diluted 2,473 2,473
======== ========
The accompanying notes are an integral part of these statements.
F-4
<PAGE>
SURREY, INC.
STATEMENT OF SHAREHOLDERS' EQUITY
(in thousands, except share data)
For the two years ended December 31, 1999
<TABLE>
<CAPTION>
Retained
earnings Total
Shares Warrants (accumulated shareholders'
outstanding Amount outstanding Amount deficit) equity
----------- ------ ----------- ------ ----------- ---------
<S> <C> <C> <C> <C> <C> <C>
Balances at January 1, 1998 2,472,727 $ 4,120 675,000 $ 65 $ (24) $ 4,161
Payment of issuance costs -- (21) -- (1) -- (22)
Net loss -- -- -- -- (849) (849)
--------- --------- --------- --------- --------- ---------
Balances at December 31,
1998 2,472,727 4,099 675,000 64 (873) 3,290
Net earnings -- -- -- -- 159 159
--------- --------- --------- --------- --------- ---------
Balances at December 31,
1999 2,472,727 $ 4,099 675,000 $ 64 $ (714) $ 3,449
========= ========= ========= ========= ========= =========
</TABLE>
The accompanying notes are an integral part of this statement.
F-5
<PAGE>
SURREY, INC.
STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Years ended
December 31,
1999 1998
------- -------
<S> <C> <C>
Operating activities
Net earnings (loss) $ 159 $ (849)
Adjustments to reconcile net earnings (loss) to net cash
provided by (used in) operating activities
Gain on disposal of property and equipment -- (2)
Depreciation 390 279
Deferred income taxes 105 (371)
Changes in operating assets and liabilities:
Accounts receivable (2,378) (286)
Inventories (606) (980)
Prepaid expenses and other current assets 292 (276)
Trade accounts payable 1,015 529
Accrued expenses 108 (35)
Income taxes receivable 116 (114)
------- -------
Net cash used in operating activities (799) (2,105)
Investing activities
Proceeds from sale of property and equipment -- 10
Purchase of property and equipment (449) (1,954)
------- -------
Net cash used in investing activities (449) (1,944)
Financing activities
Payment of notes payable -- (895)
Proceeds from issuance of long-term debt 1,500 3,300
Payment of long-term debt (134) (1,234)
Principal payments on capital lease obligations (195) (89)
Payment of issuance costs -- (22)
------- -------
Net cash provided by financing activities 1,171 1,060
------- -------
Decrease in cash and cash equivalents (77) (2,989)
Cash and cash equivalents, beginning of year 77 3,066
------- -------
Cash and cash equivalents, end of year $ -- $ 77
======= =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the period for:
Interest $ 409 $ 248
Income taxes -- --
Acquisition of property and equipment under capital leases $ 11 $ 522
Acquisition of property and equipment with long-term debt $ 458 $ 11
</TABLE>
The accompanying notes are an integral part of these statements.
F-6
<PAGE>
SURREY, INC.
NOTES TO FINANCIAL STATEMENTS
December 31, 1999 and 1998
(in thousands, except per share data)
NOTE A - NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES
Nature of Operations
Surrey, Inc. (the "Company") specializes in the development and manufacture
of high quality transparent glycerin and specialty soap products, as well as
the production of certain personal care and home fragrance products for
major drug, grocery and discount retailers and distributes its products on a
nationwide basis. The Company also manufactures and sells home fragrance
products and a full line of potpourri products as part of its crafts market
product line. The Company recently began manufacturing a line of high-end
scented candles that compliments its line of home fragrance products. The
Company conducts its business within one industry segment.
Recognition of Revenue
Revenue is recognized at the time of shipment. Provision is made for
estimated product returns.
Cash and Cash Equivalents
The Company considers all investments with maturities of ninety days or less
when purchased to be cash equivalents.
Inventories
Inventories are stated at the lower of cost or market, with cost being
determined using the first-in, first-out (FIFO) method.
Property and Equipment
Property and equipment are stated at cost. Cost includes expenditures for
major renewals and improvements and interest costs associated with
significant capital additions. For the year ended December 31, 1998, the
Company capitalized approximately $23,000 of interest. Depreciation is
recorded using the straight-line method over estimated useful lives as
follows:
Equipment 3 to 7 years
Building 40 years
Automobiles 3 years
Furniture and fixtures 5 years
Assets recorded under capital leases are amortized using the straight-line
method over the lesser of the estimated useful lives of the assets or the
term of the related leases, and such amortization is included in
depreciation expense. Repairs and maintenance are charged to expense when
incurred.
F-7
<PAGE>
SURREY, INC.
NOTES TO FINANCIAL STATEMENTS - CONTINUED
December 31, 1999 and 1998
(in thousands, except per share data)
NOTE A - NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES - CONTINUED
Use of Estimates
The preparation of financial statements in accordance with accounting
principles generally accepted in the United States which requires management
to make estimates and assumptions that affect reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date
of the financial statements and reported amounts of revenues and expenses
during the reporting period in the financial statements and accompanying
notes. Actual results could differ from these estimates.
Advertising
Advertising costs are expensed as incurred. Advertising expense was
approximately $68,000 and $59,000 for the years ended December 31, 1999 and
1998, respectively.
Earnings Per Share
The Company computes basic earnings per share based on net earnings or loss
divided by the weighted average number of common shares outstanding. Diluted
earnings per share is based on the weighted average number of common shares
plus any dilutive stock options or warrants.
Options to purchase 305,500 shares of common stock at exercise prices
ranging from $4.00 to $4.40 per share, warrants to purchase 675,000 shares
of common stock at $4.80 per share and a warrant to purchase 62,500 Units
(consisting of two shares of common stock and one redeemable common stock
purchase warrant) at $9.75 per Unit were outstanding during 1999 and 1998
but were not included in the computation of diluted earnings per share
because the exercise prices were greater than the average market price of
the common shares; therefore, the effect would be antidilutive.
Stock-Based Compensation
The Company accounts for its employee stock-based compensation using the
intrinsic value method in which compensation, if any, is measured by the
excess of the exercise price over the fair value of underlying securities.
Fair Value of Financial Instruments
Cash, accounts receivable, trade accounts payable and accrued expenses are
stated at cost which approximates fair value due to the short-term maturity
of these instruments. All significant debt instruments carry variable
interest rates and their carrying value approximates fair value.
F-8
<PAGE>
NOTE B - INVENTORIES
Inventories consist of the following at December 31:
1999 1998
------- -------
Raw materials $ 1,991 $ 1,307
Work in progress 266 447
Finished goods 581 478
------- -------
$ 2,838 $ 2,232
======= =======
NOTE C - PROPERTY AND EQUIPMENT
1999 1998
------- -------
Equipment $ 3,075 $ 2,659
Building 2,752 2,325
Automobiles 145 93
Furniture and fixtures 97 96
------- -------
6,069 5,173
Accumulated depreciation and amortization (2,113) (1,744)
------- -------
3,956 3,429
Land 281 281
------- -------
Property and equipment, net $ 4,237 $ 3,710
======= =======
F-9
<PAGE>
NOTE D - LONG-TERM DEBT
<TABLE>
<CAPTION>
1999 1998
------ ------
<S> <C> <C>
Borrowings under a $2.5 million revolving line of credit (the "Line"),
bearing interest at the bank's prime rate (8.5% at December 31, 1999),
plus 1%, with interest due monthly and all principal due in April 2000.
The Line is collateralized by accounts receivable, inventory and property
and equipment. Amounts available under the Line are subject to certain
borrowing base
limitations. $2,500 $1,000
Notes payable to a bank under a $2,300 construction advance (the "Notes")
converting to a single term note in January 1999, approximately $1,939
bearing interest at the London Interbank Offered Rate (LIBOR) plus 1.75%
(7.3% at December 31, 1999) and approximately $361, bearing interest at
the bank's prime rate (8.5% at December 31, 1999), monthly principal
payments of approximately $10 due monthly from January 2000 through April
2000, then increasing to approximately $13 through April 2005, the
maturity date of the Notes. The Notes are collateralized by
accounts receivable, inventory and property and equipment. 2,570 2,300
Notes payable to various banks for automobiles, bearing interest at rates
ranging from 7.75% to 8.75%, due in monthly installments of principal and
interest of approximately $1, maturing at various dates through January
2003. The notes are
collateralized by automobiles. 80 26
------ ------
5,150 3,326
Less current maturities 418 (134)
------ ------
Long-term debt, less current maturities $4,732 $3,192
====== ======
</TABLE>
The Line and the Notes contain restrictive covenants which require the
Company to maintain certain financial ratios.
On March 29, 2000, the Company reached agreement with its lender on new
financing arrangements for the Line which expires in April 2000. Under the
new agreement, the Company will have $1 million of the Line currently
outstanding transferred into a new term loan due in 36 monthly installments
of $27,778 plus interest at prime plus 1% beginning in July 2000.
Additionally, the Company will have available a $3 million line of credit
which will bear interest at prime plus 1%. Under the terms of the new
agreement, the Company will have $1.5 million of additional credit available
subject only to borrowing base requirements under the new agreement.
F-10
<PAGE>
NOTE D - LONG-TERM DEBT - CONTINUED
Maturities of long-term debt, as determined using the new financing
arrangement, are as follows at December 31:
2000 $ 418
2001 2,555
2002 223
2003 213
2004 140
Thereafter 1,601
-----
Total $5,150
=====
NOTE E - LEASES
The Company leases certain equipment under capital and operating leases.
Commitments for minimum rentals under non-cancelable leases as of December
31, 1999 are as follows:
Capital Operating
Year ending December 31, leases leases
------------------------ -------- --------
2000 $ 234 $ 469
2001 186 469
2002 14 378
2003 6 348
2004 1 348
Thereafter - 283
----- ------
Total minimum lease payments 441 $2,295
======
Less amount representing interest (41)
-----
Present value of minimum lease payments 400
Less current maturities (204)
-----
$ 196
=====
Rent expense was approximately $70,000 and $43,000 in 1999 and 1998,
respectively.
Property and equipment include the following amounts for capitalized leases
at December 31, 1999 and 1998:
1999 1998
---- ----
Equipment $ 759 $ 748
Less accumulated amortization (191) (117)
----- -----
$ 568 $ 631
===== =====
F-11
<PAGE>
NOTE F - INCOME TAXES
Deferred income taxes consist of the following:
December 31,
-----------------------
1999 1998
----- ----
Deferred tax liabilities:
Property and equipment $ 75 $ 59
Deferred tax assets:
Net operating losses 188 237
Allowance for doubtful accounts 44 39
Inventory and other 99 143
---- ----
Total deferred tax assets 331 419
---- ----
Net deferred tax assets $256 $360
==== ====
The Company has net tax operating losses of approximately $550,000 which
will expire in 2018.
Significant components of the provision (benefit) for income taxes
attributable to operations are as follows:
Year ended
December 31,
----------------------
1999 1998
---- -----
Current
Federal $ - $(105)
State - (9)
----- -----
Total current - (114)
Deferred
Federal 105 (341)
State - (30)
----- -----
Total deferred 105 (371)
----- -----
$ 105 $(485)
===== =====
F-12
<PAGE>
NOTE F - INCOME TAXES - CONTINUED
The reconciliation of income tax at the U.S. federal statutory tax rate to
income tax expense is:
Year ended
December 31,
----------------------
1999 1998
---- ----
Tax at federal statutory rate 34% (34)%
State taxes, net of federal benefit 3 (3)
Permanent differences and other 3 1
--- ---
40% (36)%
=== ===
NOTE G - SHAREHOLDERS' EQUITY
Warrants
As of December 31, 1999 and 1998, the Company had outstanding 675,000
warrants to purchase common stock. Each warrant entitles the holder thereof
to purchase one share of common stock at $4.80 per share. The warrants
expire on December 9, 2002. The warrants have a call provision whereby the
Company may call the warrants at a price of $0.01 per warrant at any time
that the market value of the common stock exceeds $5.00 per share for a
period of twenty consecutive trading days.
Also outstanding as of December 31, 1999, were warrants with which the
Underwriter of the Company's initial public offering could purchase from the
Company an aggregate of 62,500 Units at $9.75 per Unit. The warrants expire
on December 2, 2002.
Stock Options
The Surrey, Inc. 1997 Long-Term Incentive Plan to provide for the grant of
incentive and nonqualified stock options, stock appreciation rights,
restricted stock, performance awards or any combination thereof to
employees, under which 350,000 shares of common stock are reserved for
issuance. The exercise price of each option shall equal the fair market
value of the Company's common stock on the date of grant (110% of the fair
market value in the case of options granted to a person possessing 10% or
more of the combined voting power of the Company as of the date of grant).
The stock options generally vest over a four to five year period. The term
of each option shall not exceed 10 years from the date of grant (five years
in the case of options granted to a person possessing 10% or more of the
combined voting power of the Company as of the date of grant).
F-13
<PAGE>
NOTE G - SHAREHOLDERS' EQUITY - CONTINUED
Stock appreciation rights may be granted by themselves or in tandem with a
stock option. Stock appreciation rights granted in tandem with an option
shall become nonexercisable upon the exercise of the option and an option
granted in tandem with stock appreciation rights shall become nonexercisable
upon the exercise of the rights. The term of stock appreciation rights shall
not exceed 10 years from the date of grant. No grants of stock appreciation
rights had been made as of December 31, 1999.
Restricted stock shall be subject to a restricted period as determined by
the Board of Directors. The Board of Directors may provide for the lapse of
restrictions in installments, upon the occurrence of certain events, or upon
other terms and conditions as the Board of Directors deems appropriate. No
grants of restricted stock had been made as of December 31, 1999.
Performance awards shall be awarded to individuals specified by the Board of
Directors based upon the achievement of long-term performance goals. The
Board of Directors shall define performance objectives with a performance
period of not less than five years, and establish a fixed or variable value
for each performance award (which may be expressed in terms of specified
dollar amounts or a specified number of shares) at the date of the award.
Payments related to performance awards may be made in lump sum or in
installments, and shall be subject to such vesting, deferral or other terms
and conditions as the Board of Directors may determine. No grants of
performance awards had been made as of December 31, 1999.
The Surrey, Inc. 1997 Non-Employee Directors' Stock Option Plan (the
"Directors' Plan") under which 100,000 shares of common stock are reserved
for issuance. This Directors' Plan allows for two types of stock option
grants; an initial grant of 6,000 options effective on the Company's public
offering, with options vesting one third upon the first anniversary of the
grant date, and one third on each of the next two anniversaries of the grant
date; and an annual grant of 2,000 shares upon re-election to the Board for
a fourth or subsequent term, with options vesting immediately. The exercise
price of each option shall equal the fair market value of the Company's
common stock on the date of grant. All options expire ten years from the
date of grant.
F-14
<PAGE>
NOTE G - SHAREHOLDERS' EQUITY - CONTINUED
A summary of the Company's stock option activity and related information
follows:
<TABLE>
<CAPTION>
Weighted-
average Range of
exercise exercise
Shares prices prices
-------- ---------- --------
<S> <C> <C> <C>
Options outstanding January 1, 1998 305,500 4.07 4.00 - 4.40
Granted 30,000 4.00 -
Canceled (30,000) 4.00 -
-------- ---- ------------
Options outstanding December 31, 1998 and 1999 305,500 $4.07 $4.00 - 4.40
======== ==== ===========
Options exercisable at:
December 31, 1999 125,000
December 31, 1998 64,000
Weighted average fair value of options granted in 1998 $0.77
</TABLE>
The following is additional information relating to options outstanding at
December 31, 1999:
<TABLE>
<CAPTION>
1999
-------
<S> <C>
Exercisable
Weighted-average exercise prices of options exercisable $4.08
Weighted-average remaining contractual life of options
outstanding 7 years
</TABLE>
Pro forma net earnings (loss) and net earnings (loss) per share, as if the
Company had accounted for employee stock options at fair value is as
follows:
<TABLE>
<CAPTION>
1999 1998
------ ------
<S> <C> <C>
Net earnings (loss)
As reported $159 $(849)
Pro forma $ 36 $(971)
Basic and diluted earnings (loss) per share
As reported $.06 $(.34)
Pro forma $.01 $(.39)
</TABLE>
F-15
<PAGE>
NOTE G - SHAREHOLDERS' EQUITY - CONTINUED
The fair value of these options was estimated at the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions:
1998
--------
Risk-free interest rate 6%
Dividend yield 0%
Expected life 5 years
Volatility factor 26%
Shares Reserved
Common stock reserved at December 31, 1999
consists of the following:
For exercise of stock options 450,000
For exercise of common stock warrants 675,000
For exercise of Unit warrants 187,500
----------
1,312,500
=========
NOTE H - CONCENTRATIONS OF CREDIT RISK AND SALES TO MAJOR CUSTOMERS
The Company is engaged in the manufacturing and distribution of personal and
home care products within the United States. Consequently, the Company's
ability to collect the amounts due from customers may be affected by
economic fluctuations within the United States and the major drug, grocery
and discount retailer industry.
For the years ended December 31, 1999 and 1998, sales to one customer
amounted to approximately $7,666 and $2,443, respectively.
NOTE I - CONTINGENCIES
The Company is involved in certain claims arising in the normal course of
business. An estimate of the possible loss resulting from these matters
cannot be made; however, the Company believes that the ultimate resolution
of these matters will not have a material adverse effect on its financial
position, results of operations, or cash flows.
F-16
EXHIBIT 10.18
SURREY, INC.
2000
LONG-TERM INCENTIVE PLAN
The purpose of the SURREY, INC. 2000 LONG-TERM INCENTIVE PLAN (the
"Plan") is to promote the growth and profitability of SURREY, INC. (the
"Company") and its affiliates by providing its employees, directors, and others
with an incentive to achieve long-term corporate objectives, to attract and
retain executives of outstanding competence, and to provide its executives with
an equity interest in the Company.
1. STOCK SUBJECT TO PLAN.
a. AGGREGATE LIMIT. An aggregate of 1,000,000 shares (the "Shares")
of the common stock, no par value, of the Company ("Company Stock") may be
subject to awards granted under the Plan. Such Shares may be authorized but
unissued Company Stock or authorized and issued Company Stock that has been
acquired by the Company. Except to the extent otherwise provided in paragraph
6.b., Shares that are forfeited, and Shares that are subject to an award which
expires or is canceled, shall be available for reissuance under the Plan.
b. INDIVIDUAL LIMIT. Not more than 100,000 Shares may be subject to
awards granted to any individual during any calendar year. If an award granted
to an individual is canceled, the canceled award will continue to be counted
against the maximum number of shares for which awards may be granted to that
individual. If, after grant, the exercise price of a stock option is reduced,
the reduction shall be treated as a cancellation of the option and the grant of
a new option for purposes of this paragraph.
2. ADMINISTRATION.
a. COMMITTEE. The Plan shall be administered by a committee (the
"Committee") consisting of the Board of Directors of the Company (the "Board"),
or of not less than two members of the Board each of whom is a "nonemployee
director" within the meaning of Rule 16b-3(a)(3) under the Securities Exchange
Act of 1934 (the "Exchange Act"). To the extent feasible, at any time when the
Company is registered under Section 12 of the Exchange Act, each member of the
Committee shall be an "outside director" within the meaning of Section
162(m)(4)(C)(i) of the Internal Revenue Code of 1986 (the "Code") and
regulations thereunder.
b. POWERS AND DUTIES. The Committee shall have sole discretion and
authority to:
i. adopt rules and regulations governing the administration of
the Plan;
ii. select eligible individuals to whom awards will be
granted;
iii. determine the type, price, amount, size, and terms of
awards;
iv. determine when awards will be granted;
<PAGE>
v. determine whether restrictions will be placed on Shares
purchased pursuant to an option or issued pursuant to an award;
and make all other determinations necessary or advisable for the administration
of the Plan. The Committee's determinations need not be uniform, and may be made
by it selectively among persons who are eligible to receive awards, whether or
not such persons are similarly situated. All interpretations, decisions, or
determinations made by the Committee shall be final and conclusive.
3. ELIGIBILITY. Any employee of the Company or its Affiliates shall be
eligible to receive awards under the Plan. In addition, any director of the
Company, and any individual (other than a director of the Company) who is not an
employee of the Company or an Affiliate and who is rendering services to the
Company or an Affiliate at the request of the Board of Directors or the
President of the Company, shall be eligible to receive awards of nonqualified
stock options, stock appreciation rights, restricted stock, or performance
awards under the Plan. An "Affiliate" is any corporation that is a "parent
corporation" or a "subsidiary corporation" with respect to the Company, as
determined under Sections 424(e) and (f) of the Code.
4. AWARDS. The Committee may make awards in the form of stock options,
stock appreciation rights, restricted stock, performance awards, or any
combination thereof.
5. STOCK OPTIONS. A stock option shall entitle the optionee, upon
exercise, to purchase Shares at a specified price during a specified period.
Stock options may be "Incentive Stock Options" within the meaning of Section 422
of the Code, options which do not qualify as Incentive Stock Options
("Nonqualified Options"), or a combination of Incentive Stock Options and
Nonqualified Options. Stock options shall be subject to the following
requirements:
a. TYPE OF OPTION. Each option shall be identified as an Incentive
Stock Option or a Nonqualified Option. If a combination of Incentive Stock
Options and Nonqualified Options are granted in a single award, the
agreement evidencing the award shall specify the extent to which the
options are Incentive Stock Options and the extent to which they are
Nonqualified Options.
b. TERM. No option shall be exercisable more than ten years after
the date it is granted.
c. PAYMENT. The purchase price of Shares subject to an option shall
be payable in full when the option is exercised. Payment may be made in
cash, in shares of Common Stock having a fair market value on the date of
exercise which is equal to the option price, by directing the Company to
withhold from the Shares that would otherwise be issued upon exercise a
number of Shares having a fair market value on the date of exercise which
is equal to the exercise price, or by any combination of the foregoing,
subject to such terms and conditions as the Committee deems necessary or
appropriate. The Committee, in its discretion, may also establish, or
cooperate with an optionee who participates in, a cashless exercise
program of a broker or other agent, under which: (i) all or part of the
Shares
-2-
<PAGE>
received upon exercise of an option are sold through the broker or other
agent; or (ii) the broker or other agent makes a loan to such optionee.
d. INCENTIVE STOCK OPTIONS. An Incentive Stock Option shall be
subject to the following additional requirements:
i. The purchase price of Shares subject to the option shall
not be less than the fair market value of the Shares at the time the
option is granted, as determined in good faith by the Committee.
ii. The fair market value (determined at the time the option
is granted) of all Shares with respect to which Incentive Stock
Options first become exercisable during any calendar year, under
this Plan or any other plan of the Company or an Affiliate, shall
not exceed $100,000.
iii. If the optionee owns 10% or more of the total combined
voting power of all classes of stock of the Company or an Affiliate
at the time the option is granted, the purchase price of Shares
subject to the option shall not be less than 110% of their fair
market value on the date the option is granted, and the option may
not be exercised more than five years after the date it is granted.
The rules of Section 424(d) of the Code shall apply in determining
the stock ownership of any optionee.
iv. The option shall not be transferable except to the extent
permitted by the agreement evidencing the option. An Incentive Stock
Option agreement may only permit the option to be transferred by
will or the laws of descent and distribution, and an Incentive Stock
Option may not be exercised during the optionee's lifetime by anyone
other than the optionee.
Subject to the foregoing, options may be made exercisable in one or more
installments, upon the happening of certain events, or upon such other terms and
conditions as the Committee shall determine.
6. STOCK APPRECIATION RIGHTS. A stock appreciation right shall entitle
the holder, upon exercise, to receive a payment equal to the amount by which the
fair market value of one Share on the date the right is exercised exceeds the
"base amount" established by the Committee on the date the right is granted.
Stock appreciation rights shall be subject to the following requirements:
a. TYPE OF RIGHT. Stock appreciation rights may be granted in tandem
with an option or as "freestanding" rights.
b. TANDEM RIGHTS. Stock appreciation rights granted in tandem with
an option shall become nonexercisable upon exercise of the option, and an
option granted in tandem with stock appreciation rights shall become
nonexercisable upon the exercise of the rights.
-3-
<PAGE>
Shares subject to an option which becomes nonexercisable by virtue of the
exercise of a tandem right shall not be available for subsequent awards
under the Plan.
c. TERM. No stock appreciation right shall be exercisable more than
ten years after the date it is granted.
d. PAYMENT. The amount payable upon the exercise of a stock
appreciation right may be paid in cash, in shares of Company Stock having
a fair market value which is not more than the amount payable on the date
of exercise, or in a combination of cash and such shares, as the Committee
shall determine.
e. RIGHTS NOT TRANSFERABLE. A stock appreciation right shall not be
transferable except to the extent permitted by the agreement evidencing
the right.
f. RIGHTS IN TANDEM WITH ISOs. Stock appreciation rights granted in
tandem with an Incentive Stock Option shall be subject to the following
additional requirements:
i. The base amount of the rights shall not be less than the
purchase price of the Shares subject to the option.
ii. The rights may be exercised only when the fair market
value of the Shares subject to the rights exceeds the purchase price
of the Shares subject to the option.
iii. The rights may be exercised only when, and to the extent,
the option may be exercised.
iv. The rights may be transferred only when the option may be
transferred.
v. The amount payable upon exercise of the rights shall not
exceed the difference between the fair market value of the Shares
subject to the right and the purchase price of the
Shares subject to the option. Subject to the foregoing, stock appreciation
rights may be made exercisable in one or more installments, upon the happening
of certain events, or upon such other terms and conditions as the Committee
shall determine.
7. RESTRICTED STOCK. Restricted stock awards shall entitle the holder to
receive Shares subject to forfeiture if specified conditions are not satisfied
at the end of a restricted period. Restricted stock awards shall be subject to
the following requirements:
a. RESTRICTED PERIOD. The Committee shall establish a restricted
period during which the holder will not be permitted to sell, transfer,
pledge, encumber, or assign the Shares subject to the award. Within these
limits, the Committee may provide for the lapse
-4-
<PAGE>
of restrictions in installments, upon the occurrence of certain events, or
upon such other terms and conditions as the Committee deems appropriate.
Any attempt by a holder to dispose of restricted Shares in a manner
contrary to the applicable restrictions shall be void, and of no force or
effect.
b. RIGHTS DURING RESTRICTED PERIOD. Except to the extent otherwise
provided herein or under the terms of a restricted stock agreement, the
holder of restricted Shares shall have all of the rights of a stockholder
in the Company with respect to the restricted Shares, including the right
to vote the Shares and to receive dividends and other distributions.
However, all stock dividends, stock rights, and stock issued upon
split-ups or reclassifications of Shares shall be subject to the same
restrictions as the Shares with respect to which they are issued, and may
be held in custody as provided below until the restrictions have lapsed.
c. FORFEITURES. Except to the extent otherwise provided in a
restricted stock agreement, restricted Shares shall be forfeited to the
Company, and all rights of the holder with respect to such Shares shall
terminate, if the holder shall cease to be an employee of the Company and
its Affiliates or if any condition established by the Committee for the
release of any restriction shall not have occurred prior to the end of the
restricted period.
d. CUSTODY. The Committee may provide that certificates evidencing
restricted Shares shall be held in custody by a bank or other institution,
or by the Company or an Affiliate, until the restrictions have lapsed. The
Committee may also require the holder of restricted Shares to deliver a
stock power to the Company, endorsed in blank, relating to the restricted
Shares.
e. CERTIFICATES. A recipient of restricted Shares shall be issued a
certificate or certificates evidencing such Shares. Such certificates
shall be registered in the name of the recipient, and shall bear a legend
which shall be in substantially the following form:
"The transferability of this certificate and the shares represented
hereby are subject to the terms and conditions (including
forfeiture) of the Surrey, Inc. 2000 Long-Term Incentive Plan and a
Restricted Stock Agreement entered into between the registered owner
and Surrey, Inc. Copies of such Plan and Agreement are on file in
the offices of Surrey, Inc., 1311 Trails End Road, Leander, Texas
78641."
8. PERFORMANCE AWARDS. Performance awards shall entitle the recipient to
receive future payments of cash or distributions of Shares upon the achievement
of long-term performance goals. Performance awards shall be subject to the
following requirements:
a. PERFORMANCE PERIOD. The Committee shall establish a performance
period of not more than five years.
b. AMOUNT OF AWARDS. The Committee shall establish a value for each
performance award, which may be expressed in terms of specified dollar
amounts or a
-5-
<PAGE>
specified number of Shares. Such value may be fixed or variable in
accordance with criteria specified by the Committee at the time of the
award.
c. PERFORMANCE OBJECTIVES. The Committee shall establish performance
objectives to be achieved during the performance period, determining the
extent to which an employee will be entitled to distributions with respect
to the award.
d. PERFORMANCE MEASURES. Performance objectives may relate to
corporate, subsidiary, unit, or individual performance, or any combination
thereof, and may be established in terms of growth in gross or net
earnings, earnings per share, ratio of earnings to equity or assets, Share
value, or such other measures as the Committee shall determine. Multiple
objectives may be used which have the same or different weighting, and the
objectives may relate to absolute performance or to relative performance
measured against other companies, subsidiaries, units, or individuals.
e. ADJUSTMENTS. Prior to the end of a performance period, the
Committee may adjust previously established performance objectives to
reflect major unforeseen events such as changes in applicable laws,
regulations, or accounting practices; mergers, acquisitions, or
divestitures; or other unusual or non-recurring events.
f. DISTRIBUTIONS WITH RESPECT TO AWARDS. Following the end of a
performance period, the Committee shall determine the extent to which the
performance objectives for such period have been achieved and the amounts,
if any, that are payable with respect to performance awards for that
period. Such amounts may be paid in cash or in Shares (based on their fair
market value at the time of the payment), or in any combination of cash
and Shares, as the Committee shall determine. Payments may be made in a
lump sum or in installments, and shall be subject to such vesting,
deferral, or other terms and conditions as the Committee may determine.
g. NONTRANSFERABILITY. A performance award shall not be assignable
or transferable except to the extent permitted by the agreement evidencing
the award.
9. AGREEMENTS. Each award shall be evidenced by an agreement setting forth
the terms and conditions upon which it is granted. Multiple awards may be
evidenced by a single agreement. Subject to the limitations set forth in the
Plan, the Committee may, with the consent of the person to whom an award has
been granted, amend an agreement to modify the terms or conditions of any award.
10. ADJUSTMENTS. If there is a change in the outstanding Shares of Company
Stock by reason of a stock dividend or split, recapitalization,
reclassification, combination, or exchange of Shares, or by reason of a similar
corporate change, the Committee may adjust the number of Shares subject to an
award, the option price or value of an award, the maximum number of Shares
subject to this Plan, or the maximum number of Shares subject to an award, as
may be appropriate to reflect
-6-
<PAGE>
the nature of the change. Any such adjustments shall be conclusive and binding
for all purposes of this Plan.
11. MERGER, CONSOLIDATION, ETC. Subject to the provisions of the agreement
evidencing an award, if the Company becomes a party to a corporate merger,
consolidation, major acquisition of property for stock, spinoff, reorganization,
or liquidation, the Board may make any arrangement it deems advisable with
respect to outstanding awards, in the number of Shares subject to this Plan, and
in the number of Shares subject to awards to any individual. Such an arrangement
may include, but shall not be limited to, the substitution of new awards for
awards then outstanding, the assumption of any award, and the termination of any
award. Any such arrangements shall be conclusive and binding for all purposes of
this Plan.
12. INDEMNIFICATION. Each member of the Committee and the Board shall be
indemnified by the Company against any loss, cost, liability, or expense that
may be imposed upon or reasonably incurred by him as a result of any claim,
action, suit, or proceeding in which he may be involved by reason of any action
taken or omitted under this Plan; provided, such person gives the Company an
opportunity, at its own expense, to handle and defend the same before he
undertakes to handle and defend it on his own behalf. The foregoing right of
indemnification shall not be exclusive of any other rights of indemnification to
which any person may be entitled under the Company's articles of incorporation
or bylaws, as a matter of law, or otherwise.
13. RIGHTS AS STOCKHOLDER. Except to the extent otherwise specifically
provided herein, the recipient of an award shall have no rights as a stockholder
with respect to Shares sold or issued pursuant to the Plan until certificates
for such Shares have been issued to such person.
14. GENERAL RESTRICTIONS. Each award granted pursuant to the Plan shall be
subject to the requirement that if, in the opinion of the Committee:
a. the listing, registration, or qualification of any Shares related
thereto upon any securities exchange or under any state or federal law;
b. the consent or approval of any regulatory body; or
c. an agreement by the recipient with respect to the disposition of
any such Shares;
is necessary or desirable as a condition of the issuance or sale of such Shares,
such award shall not be consummated unless and until such listing, registration,
qualification, consent, approval, or agreement is effected or obtained in form
satisfactory to the Committee.
15. EMPLOYMENT RIGHTS. Nothing in this Plan, or in any agreement entered
into under the Plan, shall confer upon any employee the right to continue in the
employ of the Company or its Affiliates, or affect the right of the Company or
any Affiliate to terminate an employee's employment at any time, with or without
cause. In addition, nothing in this Plan, or in any agreement entered into under
the Plan, shall confer upon any individual who is rendering services to
-7-
<PAGE>
the Company or an Affiliate other than as an employee the right to continue to
render such services, or affect the right of the Company or any Affiliate to
terminate such services at any time, with or without cause.
16. WITHHOLDING. If the Company proposes or is required to issue Shares
pursuant to the Plan, it may require the recipient to remit to it, or withhold
from such award or from the recipient's other compensation, an amount sufficient
to satisfy any tax withholding requirements prior to the delivery of
certificates for the Shares.
17. AMENDMENTS. The Board may at any time, and from time to time, amend
the Plan in any respect, except that no amendment:
a. increasing the number of Shares available for issuance or sale
pursuant to the Plan (other than as permitted by paragraphs 10 and 11); or
b. changing the classification of individuals eligible to
participate in the Plan or the definition of an Affiliate;
shall be made without stockholder approval.
18. CONTINGENT AWARDS. Any award granted under the Plan prior to the date
on which the Plan is approved by the Company's stockholders shall be contingent
upon such approval. If stockholder approval is not received within 12 months
after the date on which this Plan is adopted by the Board, such award shall be
void and of no force or effect.
19. STOCKHOLDER APPROVAL. The approval of the Plan or any amendment by the
Company's stockholders must comply with all applicable provisions of the
Company's charter, bylaws, and applicable state law prescribing the method and
degree of stockholder approval required for granting awards of the type provided
under the Plan. Absent any such prescribed method and degree of stockholder
approval, the Plan or such amendment must be approved by a simple majority vote
of stockholders voting, either in person or by proxy, at a duly held
stockholders' meeting.
20. DURATION. No awards shall be granted under the Plan after the earlier
of: (a) the date the Plan is terminated by the Board; or (b) the tenth
anniversary of the date the Plan was first approved by the Board.
21. COMPLIANCE WITH SECTION 16(b). In the case of individuals who are
subject to Section 16 of the Exchange Act, the Company intends that the Plan and
any award granted under the Plan satisfy the applicable requirements of Rule
16b-3. If a provision of the Plan or any award would otherwise conflict with
such intent, that provision, to the extent possible, shall be interpreted so as
to avoid the conflict. To the extent of any remaining irreconcilable conflict
with such intent, the provision shall be deemed void as applied to individuals
who are subject to Section 16 of the Exchange Act.
-8-
<PAGE>
22. EFFECTIVE DATE OF PLAN. The Plan was initially adopted by the Board of
Directors on March 6, 2000, and is being submitted to the shareholders for
approval on May 2, 2000.
-9-
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<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> DEC-31-1999
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